Volatility spillover effects in European equity markets

This paper investigates to what extent globalization and regional integration lead to increasing equity market interdependence. I focus on Western Europe, as this region has gone through a unique period of economic, financial, and monetary integration. More specifically, I quantify the magnitude and time-varying nature of volatility spillovers from the aggregate European (EU) and U.S. market to 13 local European equity markets. To account for time-varying integration, I use a regime-switching model to allow the shock sensitivities to change over time. I find regime switches to be both statistically and economically important. Both the EU and U.S. shock spillover intensity increased substantially over the 1980s and 1990s, though the rise is more pronounced for EU spillovers. Shock spillover intensities increased most strongly in the second half of the 1980s and the first half of the 1990s. I show that increased trade integration, equity market development, and low inflation contribute to the increase in EU shock spillover intensity. I also find evidence for contagion from the U.S. market to a number of local European equity markets during periods of high world market volatility.